It mostly goes without saying, no matter how much you earn, if you don’t save your money, you will never reach financial independence. If you’re like many Financial Slackers, you earn and you spend. So you earn more and then you spend more. You continue this pattern until one day you wake up and realize that you don’t like working. At least not working at your current job. You realize that even though you have a nice salary, your spending requires that you continue to work. You are in the success trap. Whether you earn $50,000 or $2 million per year, if you are spending everything you earn, you can’t retire. You are financially dependent. I am at a point in my life where I would rather earn less but have greater financial independence.
The easiest time to start saving is before you start spending – when you don’t make much, you aren’t spending much. As your income increases, if you can put away a big portion of that increase rather than spending it, you will create an automatic savings plan.
Find a Way to Force Yourself to Save
One of the advantages of a career in finance is the pay structure. The pay is usually pretty good, so that’s certainly nice, but I am actually referring to how you are paid. Finance jobs tend to have a base salary plus a bonus. If you are working in a corporate finance job, your bonus might be smaller, but you often get other incentives like stock options. Either way, your pay is segmented into multiple income streams.
This is a big advantage in helping you save money.
As an example, let’s say when you graduate you start out making $60,000 in base salary plus a 20% bonus for total compensation of $72,000 per year. After a few years, in a good market, you might be up to $90,000 in base salary with a 100% bonus for total compensation of $180,000 per year. And a few years after that, your base may have grown to $125,000 but your bonus is now 300%, for total compensation of $500,000 per year. The compensation growth in finance is exponential.
But even though you are earning good money, you are always a little worried that bonuses could dry up. Finance is a cyclical industry so you should never count on a bonus to pay your bills. Instead, use bonuses to pay off student loans, to make a house down payment, and to save. The pay structure creates an automatic way to save without having to live within budgets. You can feel like you spend what you earn, but in reality, you are only spending a small fraction of what you earn.
What Gets Measured Gets Managed
I was able to save quite a bit in my early years. Which is good, because as I got older, I started spending more. I had children and started spending on them. I bought a bigger house and newer and more expensive cars. But because I had saved early in my career, I benefitted from the power of long term compounding. And even though I was spending more, I was still always contributing to my retirement savings. There was a period where I launched a new business and wasn’t able to contribute, but other than during that time, I have always been saving.
But now that I am older and no longer have the same pay structure, I am forced to live within a budget. As I go through my expense budget, top 5 largest expense areas that really drive my total spending are as follows:
1) Home – mortgage, taxes, insurance, maintenance
2) Car – payment, insurance, maintenance, gas, parking
3) Shopping – groceries, gadgets, electronics
4) Dining – restaurants, Starbucks, delivery services
5) Travel – airfare, rental cars, hotels, dining
A few of these categories are fixed (mortgage, car payment) while the rest are discretionary. And some of the discretionary expenses drive off fixed expenses (i.e., property taxes, insurance, and even maintenance all correlate with the cost and size of your house).
The most critical step is to make sure your fixed expenses (and those that are correlated) do not exceed 40% of your gross income. If your fixed expenses are too high, you will never be able to compensate with lower discretionary expenses. Don’t start looking at your house and cars as if they are an investment. They are expenses.
It’s easy for these items to get out of hand. My approach to managing expenses is to withdraw my savings first and then spend. I’m not good at keeping to a budget. I spend what is available. If I make less available to spend, I can save. My general rule of thumb is that you need to be saving at least 30% of your gross income. Even at this level, it’s hard to save enough to retire much before 60 years of age. If you are targeting retirement at 40, you need to be saving 50% of your gross income.
Spending Money is Not Satisfying
Rather than buying things for satisfaction, find fulfillment elsewhere. Do something for yourself instead. Seeing my investment account grow every month is much more fulfilling than buying something new.
You can choose to spend now (immediate gratification) or save, invest, and reap the rewards later (delayed gratification). Just make sure you realize you are making a choice.